The Income Statement and Statement of Cash Flows

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The Income Statement and Statement of Cash Flows

Chapter4

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1. Understand the concept of income.2. Explain the conceptual guidelines for reporting

income.3. Define the elements of an income statement.4. Describe the major components of an income

statement.5. Compute income from continuing operations.

Objectives

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6. Compute results from discontinued operations. 7. Identify extraordinary items. 8. Prepare a statement of retained earnings. 9. Report comprehensive income.10. Explain the statement of cash flows.11. Classify cash flows as operating, investing, or

financing.

Objectives

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Concepts of Income

Capital Maintenance ConceptCapital Maintenance Concept

Under this concept, corporate income for a period of time is the amount that may be paid

to stockholders during that period and still enable the corporation to be as well off at the end of the period as it was at the beginning.

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Concepts of Income


Assume a corporation has net assets of $50,000 at the beginning and $90,000 at the end of the year, and that no additional investments or withdrawals were made.

Ending net assets $90,000 Less: Additional investment 0 Ending net assets excluding investment $90,000 Less: Beginning net assets (50,000)Total income for the year $40,000

The corporation could The corporation could pay out $40,000 to pay out $40,000 to

stockholders and still be stockholders and still be as well off at year-end.as well off at year-end.

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Concepts of Income


Assume a corporation has net assets of $45,000 at the beginning and $80,000 at the end of the year. Stock-

holders made additional capital investments of $10,000.

Ending net assets $80,000 Less: Additional investment -10,000 Ending net assets excluding investment $70,000 Less: Beginning net assets (45,000)Total income for the year $25,000

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Concepts of Income

Transactional ApproachTransactional Approach

Under this concept, a company records its net assets at their historical cost, and it does

not record changes in the asset and liabilities unless a transaction, event, or circumstance has occurred that provides reliable evidence of a change in value.

The transactional approach to income measurement is used in accounting today.

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Conceptual Reporting Guidelines

Providing information about its operating performance separately from other aspects of performance.

Presenting the results of particularly significant activities or events that predict the amounts, timing, and uncertainty of its future income and cash flows.

Providing information useful for assessing the return on investment.

The FASB suggests that a company’s income

statement can be improved by--

ContinuedContinued

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Conceptual Reporting Guidelines

Providing feedback that enables users to assess their previous predictions of income and its components.

Providing information to help assess the cost of maintaining its operating capability.

Presenting information about how effectively management has discharged its stewardship responsibilities regarding the company’s resources.

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Specific Conceptual Guidelines Those items that are judged to be unusual in amount

based on past experience should be reported separately.

Revenues, expenses, gains, and losses that are affected in different ways by changes in economic conditions should be distinguished from one another.

Sufficient detail should be given to aid in understanding the primary relationships among revenues, expenses, gains, and losses.

Guidelines on how to report revenues, expenses,

gains, and losses.

ContinuedContinued

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Specific Conceptual Guidelines When the measurements of

revenues, expenses, gains, or losses are subject to different levels of reliability, they should be reported separately.

Items whose amounts must be known for the calculation of summary indicators (e.g., rate of return) should be reported separately.

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Revenues are inflows of assets of a company or settlement of its

liabilities during a period...

…from delivering or producing goods, rendering services, or other activities that are the company’s

ongoing major or central operations.

Revenues

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Revenues

Recognition is the process of formally recording and reporting an item in a

company’s financial statements.

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Revenues

A company usually recognizes revenue at the time goods are sold or services are rendered.

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Expenses

Expenses are outflows of assets of a company or incurrences of

liabilities during a period from delivering or producing goods,...

…rendering services, or carrying out other activities that are the company’s ongoing major or

central operations.

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Cost: Asset or Expense

Transaction CostCost

ContinueContinue

If a cost results in an economic resource providing future

benefits, record it as an...

AssetAsset

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If a cost is a result of providing goods or services in a time

period, record it as an...

ExpenseExpense

Transaction CostCost

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If the benefits have been used up, the

asset is changed to an expense.

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Income Statement Content

a. Sales revenue (net)b. Cost of goods soldc. Operating expensesd. Other itemse. Income tax expense related to

continued operations

1. Income from continuing operations.

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Income Statement Content2. Results from discontinued operations.

a. Income (loss) from operations of discontinued segments (net of income taxes).

b. Gain (loss) from disposals of discontinued segments (net of income taxes).

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3. Extraordinary items (net of income taxes).4. Cumulative effects of changes in accounting

principles (net of income taxes).5. Net income.6. Earnings per share .

Income Statement Content

That’s it!

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Cost of Goods Sold:BANNER CORPORATIONSchedule 1: Cost of Goods SoldFor Year Ended December 31, 2000Inventory, January 1, 2000 $ 41,000 Purchases $80,300 Freight-in 5,500 Cost of purchases $85,800 Less: Purchases returns (2,800)Net purchases 83,000 Cost of goods available for sale $124,000 Less: Inventory, December 31, 2000 (38,000)Cost of goods sold $ 86,000

Merchandising Company

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Cost of Goods Sold:BANNER CORPORATIONSchedule 1: Cost of Goods SoldFor Year Ended December 31, 2000Raw materials used $ 35,000 Direct labor 29,000 Factory overhead

Depreciation of factory items $5,100Heat, light, and power 4,000Indirect factory labor 7,300Repairs and maintenance 3,400Miscellaneous factory expense 1,200 21,000

Current manufacturing costs $ 85,000

Manufacturing Company

ContinuedContinued

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Cost of Goods Sold:

Current manufacturing costs $ 85,000 Add: Goods in process, January 1, 2000 27,000 Less: Gods in process, December 31, 2000 (29,000)Cost of goods manufactured $ 83,000 Add: Finished goods inventory, Jan. 1, 2000 41,000 Cost of goods available for sale $124,000 Less: Finished goods inventory,

December 31, 2000 (38,000)Cost of goods sold $ 86,000

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Income Tax Expense

Interperiod tax allocation involves allocating a corporation’s income tax obligation as an expense to various

accounting periods because of temporary (timing) differences between its taxable

income and pretax financial income.

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Income Tax Expense

Intraperiod tax allocation involves allocating a corporation’s total income tax

expense for a period to the various components of its net income, retained

earnings, and other comprehensive income.

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income from continuing operations income (loss) from the operations of a discontinued

segment gain (loss) from the disposal of a discontinued segment extraordinary items cumulative effect of any change in accounting principles any prior period adjustments any items of other comprehensive income

Income Tax ExpenseIncome tax expense is matched against the following:

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Single-Step Income Statement

RevenuesSales revenue $143,700 Interest revenue 1,800 Dividend revenue 600 Total revenues $146,100

ExpensesCost of goods sold $ 86,000 Selling expense 10,200 General and admin. expense 16,000 Depreciation expense 7,800

ContinuedContinued

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Expenses (continued)Loss on sale of equipment 4,000 Interest expense 2,100 Income tax expense 6,000

Total expenses (132,100)Income from continuing operations $14,000 Results from discontinued operations

Income from operations of segment A (net of $1,950 income taxes) $ 4,550 Loss on disposal of segment A (net of $3,150 income tax) (7,350) (2,800)

Income before extraordinary items $ 11,200 ContinuedContinued

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Income before extraordinary items $ 11,200 Extraordinary loss from explosion

(net of $750 income tax credit) (1,750)Cumulative effect on prior years’

income of change in depreciationmethod (net of $600 income taxes) 1,400

Net income $ 10,850 Earnings per

Common Share (8,000 shares)Components of Income

Income from continuing operations $2.80 Results from discontinued operations (0.56) Extraordinary loss from explosion (0.35) Cumulative effect on prior years’ income 0.28 Net income $2.17

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Income Statement: Results from Discontinued Operations

The sale by a diversified company of a major

division that represented the company’s only

activities in the electronic industry.

Examples from APB No. 30Examples from APB No. 30

The sale by a diversified company of a major

division that represented the company’s only

activities in the electronic industry.

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The sale by a meat packing company of its 20% interest in a professional

football team.

Examples from APB No. 30Examples from APB No. 30

The sale by a meat packing company of its 20% interest in a professional

football team.

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Income from continuing operations $93,000 Results from discontinued operations:

Income from operations of discontinued Division X (net of $2,880 income taxes) $ 6,720 Loss on disposal of Division X (net of $6,000 income tax credit) (14,000) (7,280)

Income before extraordinary items $85,720

Reported net of taxesReported net of taxes

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Discontinued operations are reported on the income statement after the continuing operations, but before

extraordinary items.


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Component 1: operating income (loss)

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Component 2: gain or loss on disposal

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Gain or Loss on Disposal

Phase-Out Within Accounting PeriodPhase-Out Within Accounting Period

Measurement Date

7/1/001/1/00

Pretax operating income, $8,000

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Measurement Date

7/1/00


Disposal Date

12/1/00

Segment X was Segment X was sold at a loss of sold at a loss of

$10,000 $10,000 (pretax)(pretax)

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Results from discontinued operationsIncome from operations of discontinued Segment X (net of $2,400 income taxes) $ 5,600

Operating income 1/1-7/1 $ 8,000 Less taxes (30%) (2,400)

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Results from discontinued operationsIncome from operations of discontinued Segment X (net of $2,400 income taxes) $ 5,600 Loss on disposal of Segment X (net of $3,000 income tax credit) (7,000) $(1,400)

Operating income 7/1-12/1 $ 2,000 Loss on sale of segment (12,000)Loss (pretax) $(10,000)Less tax credit (30%) 3,000

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Phase-Out After Fiscal Year-EndPhase-Out After Fiscal Year-End

Measurement Date

8/1/001/1/00


*Recognized on the measurement date

*

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Measurement Date

8/1/00


Disposal Date

5/1/01



FiscalYear-End12/31/00

Pretax operating loss, $8,000

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Results from discontinued operationsIncome from operations of discontinued Segment Y (net of $4,200 income taxes) $ 9,800

Operating income 1/1-8/1 $14,000 Less taxes (30%) (4,200)


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Results from discontinued operationsIncome from operations of discontinued Segment Y (net of $4,200 income taxes) $ 9,800 Loss on disposal of Segment Y (net of $5,700 income tax credit) (13,300) $(3,500)

Operating income 8/1/00-5/1/01 $ 3,000 Loss on sale of segment (22,000)Loss (pretax) $(19,000)Less tax credit (30%) 5,700



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Extraordinary Items

An extraordinary item is an event or

transaction that is both unusual in nature and

infrequent in occurrence.

Unusual nature--the underlying event or

transaction possesses a high degree of

abnormality and is of a type clearly unrelated to,

or only incidentally related to, the ordinary and typical activities of

the company.

Infrequency of occurrence--the

underlying event or transaction is of a type that is not reasonably

expected to recur in the foreseeable future.

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The write-down or write-off of receivables, inventories, equipment leased to others, or intangible assets.

Gains or losses from exchanges or transactions of foreign currency.

Gains or losses from the disposal of a business segment.

Extraordinary ItemsEvents that the APB identified as not qualifying as extraordinary:

ContinuedContinued

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Other gains or losses from the sale or abandonment of property, plant, or equipment.

The effects of a strike. The adjustment of accruals on long-term

contracts.

Extraordinary ItemsEvents that the APB identified as not qualifying as extraordinary (continued):

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Extraordinary Items

Unusual?NoNo

Report Gain (Loss) As

Income from Continuing Operation (Other Items section)

Infrequent?NoNo

or

Income from Continuing Operation (Other Items section)

Event

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Extraordinary Items

Event

Unusual?NoNo

Report Gain (Loss) As

Infrequent?NoNo

orYesYes

YesYes

andExtraordinary

Item

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Statement of Retained EarningsBeginning retained earnings $59,200 Plus (minus): Prior period adjustment

(net of $2,400 income taxes) 5,600 Adjusted beginning retained earnings $64,800 Plus (minus): Net income (loss) 22,300

$87,100 Minus: Dividends (specifically identified,

including per share amounts) (9,400)Ending retained earnings $77,700

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Statement of Retained Earnings

Retained earnings is the link between a corporation’s

balance sheet and its income statement.

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Comprehensive Income

Recall in Chapter 3 that the FASB now requires companies to report their comprehensive income (or

loss) for the accounting period.

A company’s comprehensive income consists of two parts: net income and other comprehensive net

income. Currently, there are four items of a company’s other comprehensive income:

ContinuedContinued

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Any unrealized increases (gains) or decreases (losses) in the market value of investments in available-for-sale securities.

Any change in the excess of its additional pension liability over unrecognized prior service costs.

Certain gains and losses on “derivative” financial instruments. Any transaction adjustment from converting the financial

statements of a company’s foreign operations into U. S. dollars.


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On the face of its income statement. In a separate statement of comprehensive

income. In its statement of changes in stockholders’

equity.

Comprehensive IncomeThe FASB allows a company to report its comprehensive income under three alternatives:

The company must display the statement containing the comprehensive income as a major financial

statement in its annual report.

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In reporting its comprehensive income, a

company must add its other comprehensive

income to net income.

The other comprehensive income items may be reported at their gross amounts or net of tax.

If each item is reported at its gross amount, then the total

pretax amount of other comprehensive income must

be reduced by the related income tax expense.

A company is not required to report

earnings per share on its comprehensive income.

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Statement of Cash Flows

The company’s ability to generate positive future cash flows. The company’s ability to meet its obligations and pay

dividends. The company’s need for external financing. The reasons for differences between the company’s net

income and associated cash receipts and payments. Both the cash and noncash aspects of the company’s

investing and financing transactions.

The statement of cash flows helps users to assess--

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Operating activities include all the transactions and other events related to its earnings process.

Investing activities include all the transactions involving acquiring and selling long-term investment, acquiring and selling property, plant, and equipment,

and lending money and collecting on loans.

Financing activities include all the transactions involved in obtaining and disbursing resources from and to owners and repaying the amounts borrowed.

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The statement of cash flows includes three

major sections.

(1) Net cash flow from operating activities.

(2) Cash flows from investing activities.

(3) Cash flows from financing activities.

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• To eliminate certain amounts that were included in net income but that did not involve a cash inflow or cash outflow for operating activities.

• To include any changes in the current assets (other than cash) and current liabilities involved in the company’s operating cycle that affect cash flow differently than net income.

Statement of Cash FlowsIn the Net Cash Flows from Operating Activities section, net income is listed first and then adjustments are made to net income (indirect method)--

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• Receipts from selling investments in stocks and debt securities.

• Receipts from selling property, plant, and equipment.• Payments for investments in stocks and debt

securities.• Payments for purchases of property, plant, and

equipment.

Statement of Cash FlowsThe Cash Flows From Investing Activities section includes all the cash inflows and outflows involved in investing activities transactions of the company. Common investing activities are--

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• Receipts from the issuance of debt securities.• Receipts from the issuance of stocks.• Payment of dividends.• Payments to retire debt securities.• Payments to reacquire stock.

Statement of Cash FlowsThe Cash Flows From Financing Activities section includes all the cash inflows and outflows involved in the financing activities transactions of the company. Common financing activities are--

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Chapter4

The Income Statement and Statement of Cash Flows

Documents

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